Stick 'em up

Should board directors be forced to dig into their own pockets to settle shareholder lawsuits?

WITH all the woes in the world, it seems perverse to feel sorry for the board directors of big public companies. But in the past few years, believe it or not, directors have felt rather sorry for themselves. Many have been blamed, at least in part, for a wave of corporate scandals on both sides of the Atlantic, their reputations tarnished by the crimes of others. In the wake of those scandals, new laws have been passed, loading yet more responsibilities on to their shoulders. Appointment to a corporate board once seemed an undemanding honour, the ideal adornment to an already successful career. Today it is beginning to look more like a job from hell.

The final blow to the idea of a director's seat as a flattering corporate bauble seems to have been delivered this month with the announcements that ten former directors from each of two big firms, WorldCom and Enron, have agreed to cough up a collective $18m and $13m respectively of their own money to help settle lawsuits launched by enraged shareholders against them and their firms. This is almost unprecedented. Directors have often been sued by shareholders, and former directors of Walt Disney, Hollinger International, a newspaper group, and Britain's Equitable Life, a life assurer, are also currently the targets of high-profile lawsuits. But it is not clear yet whether any of these directors will ever have to pay a penny. Many such lawsuits fail. The usual outcome of those that succeed is for directors' legal costs and damages to be paid by directors' liability insurance (see article). So the settlements agreed by the WorldCom and Enron directors, coming so close together, sent a thrill of fear through boardrooms.

Ouch!

Let them tremble, might be many people's first reaction. But this would be a mistake. Independent directors play a vital role in shareholder capitalism, representing the interests of a usually disparate crowd of shareholders as well as providing a regular outside check on managers. Somewhat like British monarchs, directors have the right to be consulted, the right to encourage and the right to warn. But they do not usually exercise control. When their advice is ignored, or a firm runs into difficulties—whether through the fault of managers or merely as a result of routine misfortunes—serving as a director can feel like a thankless task. If, on top of this, directors now run the risk of losing large sums of their own money as well, recruiting good people to be directors will be a lot more difficult.

Fortunately, there are reasons to believe that the WorldCom and Enron cases may not lead to that bad outcome. For one thing, they are among the most egregious examples in corporate history of directors failing to do their job, and so should not establish widely followed precedents. WorldCom, a telecoms firm since renamed MCI, became the biggest bankruptcy of all time after it was discovered that it had falsely inflated its income by tens of billions, apparently with few questions from its incurious directors. Enron also collapsed spectacularly after accounting fiddles that seemed to have raised barely a peep from outside directors.

Most directors never approach these levels of negligence. Even in these two cases, the sums that directors will pay are a tiny fraction of the overall amounts sought, and are meant to penalise, not to ruin them. The WorldCom directors have agreed to pay 20% of their net worth, not counting their primary residences and retirement accounts. The Enron directors, some of whom gained by selling Enron shares before the firm collapsed, are handing over some of their trading profits.

The intent of the investing institutions which have led the lawsuits in both cases seems to be to chastise, in the hope of encouraging other directors to greater vigilance. In these two extreme instances, making directors pay some of their own money seems justified. But, it has to be admitted, striking the right balance is difficult. If a flood of lawsuits now target directors' personal assets, the supply of good directors is bound to dry up, and that would harm shareholders themselves most of all. Directors don't deserve to be pitied, and they should be held accountable. Yet they are, after all, usually watchdogs, not culprits themselves. When they fail as watchdogs, they should be shamed, but not turned into scapegoats.